August 19, 2003
Research Digest
Michael Roessler, 312.630.9880 x. 212
www.zackspro.com
Chordiant Software
155 North Wacker Drive
Chicago, IL 60606
(CHRD-NASDAQ)
Overview
Chordiant Software’s recent upside surprise and greater visibility has resulted in increased consensus
expectations and higher target prices. Greater visibility, the potential of growth in the U.S., a partnership
with IBM, new software solutions, and expected expansion into new vertical markets are propelling
analyst expectations upward.
Strengths/Opportunities
Expansion outside the financial
services vertical market.
Flexible, scaleable J2EE product
architecture cited by customers as a
current competitive advantage.
Better visibility into 3Q03.
IBM partnership.
Weakness/Threats
Modest recovery in demand for CRM is
required to support target prices.
J2EE comparative advantage could
prove temporary.
Fiscal year operating results are still
negative.
Historically lumpy business
performance.
Chordiant announced that it has $15 mil visibility for 3Q03, representing 80% of its revenue guidance for
the quarter. The company has been successful in competitive bids against larger software companies
such as Siebel to win significant customers such as USAA and CIBC. Pro forma operating results were
positive during 2Q03 for the first time in the company’s history. Currently, analysts are projecting net
income will be positive the fiscal year 2004, when an expected modest recovery in demand for CRM
software will help Chordiant’s top line to rebound.
Good cost control has surprised some analysts by reducing costs within the business model without
decreasing sales reps or the company’s ability to find and follow sales leads.
The optimistic upward revisions to analysts’ models is tempered by Chordiant’s historically lumpy
business performance. A few more quarters of strong performance seems in order to some analysts
before they announce that Chordiant has grown successfully away from the lumpy quarterly results
common to many small enterprise application providers.
© Copyright 2003, Zacks Investment Research. All Rights Reserved.
Sales
2Q03 results were better than consensus expectations. License revenue grew 56.7%. Yet the average
analyst forecast is expecting an 10.3% drop in FY03E revenues relative to FY02A. Top-line growth for
the fiscal year in expected to return in FY2004. Variance among analyst models is most significant in
forward sales expectations. One analyst (Pacific Growth) forecasts FY03E revenues to be approximately
7.5% below the average revenue forecast. Notably, this analyst maintains a positive rating on Chordiant.
Chordiant’s main vertical market is financial services, representing approximately 75% of revenue. The
financial services sector is expected to remain the primary source of revenues going forward, though
Chordiant should gradually diversify its revenue base. Outside its main financial services market, the
company has sold to the telecommunications and travel/leisure industries. Management indicates that
selling to the government sector may develop into an attractive opportunity in the future.
Est. Total Sales ($M)
2003E
$61.3 - 68.4
2004E
$69.3 - $86.4
Est. Growth
13%-26%
Chordiant closed 20 new engagements in 2Q03 versus 12 in the previous quarter. Royal Bank of
Scotland, CIBC, Prudential, and Proximus were major customers.
To date, Chordiant’s largest geographic market is Europe. Chordiant is building a pipeline in the US,
though it remain cautious regarding current US market conditions. Management indicated European
demand is stabilizing with the UK its strongest market – though France remains weak.
Chordiant has begun a partnership with IBM. To date, the company is in approximately 10 deals together
with IBM.
Significantly, management suggested that they have $15 mil in visibility for 3Q03, which is over 80% of
revenue guidance ($17-$18 mil) for the quarter.
Analysts see five major growth drivers:
1. Expanding potential and focus within the U.S.
a. To date, Chordiant generates a majority of its revenue in Europe.
2. Recent partnership with IBM
a. Analysts expect IBM and Chordiant to make joint customer announcements in the near future.
The partnership is expected to target financial services customers.
3. New products
a. Analysts expect new product announcements for provision to Chordiant’s financial services
customers.
4. Expansion of vertical markets
a. Chordiant’s revenue source is mainly within the financial services sector. Chordiant’s success
within this vertical market seems to be based on the flexibility and scalability of its software
architecture, a reason for success that can be transferred to other verticals. Management is
citing the federal government market as an area of key interest.
5. Acquisitions
a. Chordiant has not announced acquisition targets, but has stated that future M&A activity might
be implemented to acquire complimentary J2EE technology.
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Margin
Gross margins increased to 62.8% sequentially during the second quarter relative to 55.2% in the first
quarter. Average analysts expectations are for FY03E gross margins to drop from an actual 57.7% during
FY2002 to an average expected level of 55.7%.
Within the revenue segments, there is little variance among the gross margins forecasts. Gross margins
for licenses are expected to drop slightly from 95.15% in FY02 to 94.69% in FY03E. Within the service
revenue segment, gross margins are expected to increase somewhat from 59.89% in FY02 to 63.12% in
FY03E.
There is very little variance in expectations for R&D expenditures (around 20% of sales).
Sales & Marketing expenses are forecast to drop from 44% of sales in FY02 to 32% in FY03E.
2003E Margins
Gross Margin
Operating Margin
Net Margin
Low Estimate
58.06%
n/a
n/a
High Estimate
62.01%
n/a
n/a
Earnings Per Share
Chordiant reached pro forma profitability for the first time in its history. Pro forma results exclude noncash compensation, amortization of intangibles, and restructuring expense.
Consensus expectations for FY03E rose following a significant upside earnings surprise in the 2Q03
announcement. Consensus expectations are for $0.04 loss in FY03E. Analysts are forecasting a 340%
jump in year-over-year EPS performance in the 2004 fiscal year to a positive $0.10 in EPS. The variance
in FY2004 expectations is wide. (RBC Cap.) has the highest EPS expectations at $0.19, following its
recent upward model revisions and rating upgrade. Notably, the above-consensus analyst expectations
depend significantly on an expected modest recovery in demand for CRM software. A later than expected
or nonexistent recovery would threaten analyst expectations.
The single analyst with a negative rating on Chordiant (CIBC), has not yet issued quarterly projections for
the 2004 fiscal year, but does project positive results for FY2004.
The improved business backlog has caused substantial upward revisions to analyst FY03 and FY04
expectations, including one analyst’s (Pacific Growth) recent (July) switch from negative to positive
FY2004 expectations.
Management does not provide EPS guidance.
Street Consensus
Company Guidance
Low Estimate
High Estimate
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FY-2003
-$0.04
NF
-$0.06
-$0.01
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FY-2004
$0.10
NF
$0.05
$0.19
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Target Price/Valuation
Three of the five sell-side analysts have price target in the $3.00 to $4.00 range. The targets are based
multiples of expected FY2004 EPS estimates, or approximately 2x EV/FY04E Sales. There is one
exception to this range: (RBC Cap.). Recently, (August 6, 2003), (RBC Cap.) raised substantially its
forward FY2004 earnings expectations and placed a 35x multiple on those expectations to obtain a target
price of $6.50 per share. The sudden and large revision is the result of the analyst’s expectation for a
modest recovery in the CRM market generally as well as the increased visibility at Chordiant.
Long-Term Growth
Management has identified its intent to expand Chordian’t exposure beyond its traditional financial
services vertical market, and to give greater attention to the diversification of revenue sources in order to
expand beyond Chordiant’s euro-centric focus, namely by expanding presence in the US. Measuring
Chordiant’s progress toward these goals will be key metrics for forecasting long-term growth potential.
Chordiant’s customers are “singing praise” according to analysts for Chordiant’s scaleable and flexible
software architecture. The scalability and flexibility are due to Chordiant’s usage of J2EE architecture,
placing the client desktops within browsers, thereby eliminating the need for desktop updates and
installations. Siebel, for example, is still transitioning away its client/server architecture. Chordiant’s
usage of J2EE applications enables it to reduce desktop client management requirements producing a
comparative advantage. Monitoring the progress of Chordiant’s competitors in adopting similar
architecture may be significant to Chordiant as the loss of this comparative advantage could negatively
impact the company’s long-term growth potential.
Chordiant’s business performance is historically lumpy. Chordiant, like many small enterprise
applications companies, suffers from a high variance in quarterly results resulting from deals that slip
from one quarter to another. This produced in the past a regular cycle of missing one quarter’s estimates
only to bounce back the following quarter with upside surprises. Chordiant’s ability to grow away from this
trend is significant to turning short-term cyclical gains in the stock into sustainable growth in value.
Individual Analyst Opinions
POSITIVE RATINGS
JMP Securities – Strong Buy ($4.00): JMP Securities believes that Chordiant’s prospects to close new
deals within the next few months is strong enough that the analysts have increased their price target from
$3 to $4 and raised their 2004 pro forma EPS estimate from $0.09 to $0.15. JMP Securities sees little
risk of Chordiant announcing disappointing operating results. The analysts believe that Chordiant has
already achieved sales sufficient to meet both Q3 and Q4 estimates. Potential deals with a European
bank and a UK government agency could improve visibility into 2004 and add further upside to 2004
estimates. Percentage of completion accounting issues, large deals that could fail to close when
expected, and a potential competitive threat from Siebel Systems are cited as possible risks.
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Needham–Buy ($4.00): Needham’s $4.00 price target calculation is somewhat unusual. Needham starts
by multiplying 25 by both the 2004 and 2005 EPS estimates excluding interest income, then “splits the
difference” between the two values and adds prospective net cash per share of approximately $0.75.
Needham is impressed with Chordiant’s revenue growth, tight expense control, and increase in deferred
revenues. The analysts have increased estimates as a result.
Pacific Growth – Over Weight (N/A): Pacific Growth cites Chordiant’s pro forma operating profit in the
last quarter, reduction in COGS and expenses by $12 mil, and increase in service margins as positives.
Visibility is better considering that management indicates that 80% of its revenue guidance for 3Q03 of
$17 – $18 mil. Reported revenue and EPS for 2Q03 was significant above Needham’s recently raised
estimates. Chordiant reported its first ever pro forma profit. DSO’s excluding receivables related to
deferred revenue decreased to 38 from 62. Chordiant reduced debt by $1 mil (now standing at $1.6 mil in
short-term obligations).
RBC Capital – Outperform ($6.50): RBC Capital’s target price of $6.50 is the highest among the group
and represents a 48% premium to the average target price. This premium is due to the 35x multiple RBC
Capital uses for the future P/E, but more significantly, to the fact that RBC Capital’s projections for
FY2003 and FY2004 are the highest – including a FY2004 pro forma net income projection that is 84%
higher than the average. RBC Capital cites loud customer praise for the flexible architecture of
Chordiant’s system and praise of Chordiant’s strong customer commitment through after-market support.
RBC Capital cites an expectation for modest recovery in demand for CRM software as a significant factor
supporting its investment theses and $6.50 price target. RBC Capital’s analysts seem to be forecasting a
faster and greater recovery within the CRM software sector than other analysts.
NEUTRAL RATINGS
None
NEGATIVE RATINGS
CIBC Capital Markets – Underperformer (N/A): CIBC Capital is only brokerage with a negative rating
on Chordiant. In stark contrast to each of the other brokerage reports, CIBC cites revenue predictability
issues and execution risk as the reasons for its negative rating. Yet the analysts seem to contradict
themselves by calling attention within their report to “better predictability of revenue” due to several large
dollar deals and increasing deferred revenue. We interpret this seeming contradiction to mean that while
Chordiant’s revenue predictability is better than it was in recent quarters, the enhanced visibility has not
existed long enough for the analysts to have much confidence in the improvement. The analysts have
been concerned that Chordiant’s cost-cutting measures would reduce the company’s ability to close
deals. Chordiant surprised the analysts in 2Q03 by increasing sales reps even as it cut expenses –
causing CIBC to retract its concern in the latest report. CIBC Capitals wants to see more quarters
supporting the improving trend before revisiting their negative rating.
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